Why it's Time to Tax Internet Sales

Buying an $800 couch or television via the tax-free Internet can be nearly $80 cheaper than a purchase made in a high-sales-tax city like San Francisco -- such a deal. But the free ride is costing states and cities billions of dollars a year, and it damages local businesses that find it hard to compete.

The Main Street Fairness Act, introduced this month by Rep. Bill Delahunt (D-Mass.), would end the exemption for big Web retailers like Amazon.com and eBay that fear the change would be a body blow to their business. The Web sales tax issue has been debated and litigated for years, and it is hardly a popular cause, but with state and local governments deeply in debt, the chance to add a massive revenue stream may outweigh the political risks.

The seven-term Delahunt will not be running for re-election, but it would be unfair to see the timing as opportunistic. Delahunt sponsored a similar bill in 2008. I don't enjoy paying taxes any more than the next guy, but Delahunt was right then and he's right now. The Internet is no longer a baby that needs to be cosseted and protected from the real world, and favoring Internet business over brick-and-mortar ones via a tax exemption is not fair.

The budget hole provides the necessary opening for equal taxationIf you want government services, someone has to pay for them. The amount of money governments are losing due to the exemption is staggering. Uncollected use taxes (a use tax is pretty much the equivalent of a sales tax) for the six-year period ending in 2012 will range from $52 billion to $56 billion nationally, according to a 2009 study by economists at the University of Tennessee. New York City alone will lose at least $390.6 million in 2012; Chicago $229 million, they predict.

That huge black hole hasn't gone unnoticed, and several states (including North Carolina, New York, Colorado, and Rhode Island) are working on a separate track to change the rules. More states are considering similar action. And despite what you may have heard, don't think the 1998 Internet Tax Freedom Act forbids such taxation -- it doesn't. (More on that in a bit.)

On the other side are the big Internet retailers, such as Amazon.com and eBay, which have fought hard to maintain a status quo that gives them a marked advantage over local brick-and-mortar merchants. Amazon.com, the largest and best-known Web retailer, has fought efforts to collect sales tax from customers. The company argues that the crazy quilt of taxing jurisdictions -- there are approximately 8,500 in the United States -- makes doing so impractical.

Nonsense -- an industry that can deliver tailored ads to buyers in a fraction of a second could surely solve whatever technical problems exist. And it already has: Reed Hastings, the chief executive of Netflix, told the New York Times, "We collect and provide to each of the states the correct sales tax. There are vendors that specialize in this (we use Vertex). It's not very hard." Plus, national brick-and-mortar stores have done this for years.

I'm more sympathetic to the argument that small businesses on the Internet could be throttled by the policy change. However, the bill Delahunt sponsored in 2008 exempted businesses whose revenue was less than $5 million. The text of the current bill, HR 5660, likewise calls for a small-business exemption, but it does not yet specify a qualifying threshold.

The Tax Freedom Act isn't an obstacleAlthough many people believe that the Internet Tax Freedom Act stands in the way of collecting sales taxes on Web-purchased items, it doesn't. The major thrust of the law is to forbid states from imposing a sales tax on Internet connection fees. It also stops states from imposing a sales tax on items sold via the Internet that aren't taxed in brick-and-mortar stores, an unlikely form of discrimination. And it forbids collecting higher taxes for e-commerce purchases than for brick-and-mortar and mail-order purchases.

What does stop states from collecting sales taxes on e-commerce goods is a 1992 ruling by the U.S. Supreme Court that the states could not order retailers that don't have a physical presence in the state to collect sales tax. Back in 1992, that really meant mail-order catalog merchants, but by extension, it applies to Web retailers as well. However, there's nothing in the decision (Quill v. North Dakota) that forbids states from ordering buyers to pay the sales tax, says Michael Mazerov, a senior fellow at the nonpartisan Center on Budget and Policy Priorities in Washington, D.C., who has written extensively about the sales tax issue.

And it doesn't stop states from taxing a company like Amazon.com that has a brick-and-mortar affiliate within their borders. Amazon.com affiliates aren't those third-party sellers on its website; they are typically companies that have an Amazon.com ad on their own website. When a consumer clicks on the ad and goes to Amazon.com to make a purchase, the affiliate gets a cut of the revenue.

Is the free ride fair?Sure, your purchases will cost a bit more if you have to pay tax on Internet purchases. But is that relatively small savings worth the damage to your state and local governments? It's your services that will be cut.

What's more, exempting the Amazon.coms and the eBays is unfair to local merchants and to people who don't shop online, a population that tends to be older and poorer, argues Mazerov.

Raising taxes isn't popular or pleasant. But sometimes a little pain is worth enduring, especially when it makes the system fair for all.